Here’s how to qualify for a home loan.
What You Need To Qualify for a Home Loan
While requirements vary by lender and loan type, there are some overarching criteria that lenders look for regardless of those factors.
Credit Score
Your credit score is a three-digit number that shows how responsible you are as a borrower. A high credit score shows lenders that you’re likely to repay your home loan on time and in full while a lower score signifies you might fall behind on your payments or default. Therefore, homebuyers with high credit scores tend to qualify for a greater selection of home loans and lock in the lowest interest rates.
Down Payment
A down payment refers to the percentage of your home’s purchase price that you pay upfront when you close on the loan. Put simply, it’s the initial investment you make in your home. Your down payment can play a vital role in your loan’s interest rate and term, and whether or not you have to pay private mortgage insurance (PMI). A larger down payment will also reduce the loan-to-value (LTV) ratio. That’s the percentage of the home’s value that is covered by the loan. A lower LTV means less risk for the lender and (usually) lower interest rates for the borrower. While you can get a home loan with only 3% down, most mortgages require a down payment of 5% or more. The more you have to contribute to your down payment, the more affordable your home loan will be in the long run. In most cases, a down payment of less than 20% of the purchase price will require you to pay private mortgage insurance.
Debt-to-Income Ratio
Lenders will also look at your debt-to-income (DTI) ratio, which is all of your monthly debt payments divided by your gross monthly income, expressed as a percentage. Your DTI ratio will explain whether or not you have enough money coming in to cover all of your bills and potential home loan payments. Let’s say your total monthly debt payments are $3,000 and your gross monthly income is $6,000. In this case, your DTI ratio is 50%. While you may be able to find a home loan with a DTI ratio as high as 50%, a lower DTI ratio is preferred when applying for a mortgage.
Employment History
You’re more likely to get approved for a home loan with a stable employment history. Most lenders want to see that you’ve spent at least two years working in the same field, even if you’ve had different jobs. If you’re self-employed, don’t worry as lenders are usually open to extending loans to borrowers with nontraditional jobs. Just be prepared to provide your self-employment tax returns that show two years of your income history.
Overall Financial Situation
Lenders want to look at your financial situation as a whole. To do so, they’ll examine your total assets and cash reserves as this information will help them understand your ability to continue to repay your loan if you lose your job or another unforeseen situation occurs.
How To Improve Your Chances of Qualifying for a Home Loan
There are several steps you can take before you apply for a mortgage to position yourself in the best possible light.
Work on Your Credit Score
Since your credit score is a major factor in your ability to get a home loan, it’s worth your time and effort to improve it. To do so, pay all of your bills on time as even one late or missed payment can ding your score. Also, catch up on any past-due accounts and make payments on any revolving accounts like credit cards and lines of credit. In addition, limit how often you apply for new accounts.
Pay Off Debts
By paying off your debts, you’ll reduce your DTI ratio and in turn become a more attractive borrower. You can turn to DIY debt payoff strategies, like the debt avalanche or the debt snowball methods. Or you may seek professional help and work with a trusted debt settlement company or credit counselor who can help you with a debt management plan. Debt consolidation through a loan or balance transfer credit card may be an option as well.
Save for a Down Payment
If you don’t have a lot of cash on hand for a down payment, you should focus on saving money so that you’ll have a better LTV when you apply. You may want to reduce your expenses, and/or boost your income through a raise or side hustle. A larger down payment will also help lower your monthly principal payments.
Stay at Your Job
Ideally, you’d continue working for your current employer if you hope to apply for a home loan in the near future. If you’re thinking about jumping ship and finding a new job or pursuing your dream of self-employment, you may want to wait until you get approved for the home loan. Otherwise, you may have trouble proving stable employment with a steady income.
Consider a Co-Signer
A co-signer is someone who will take responsibility for your home loan in the event you default on your payments. If you don’t have the best financial situation, you may consider applying for a loan with a co-signer, like a parent or other close family member. Just be aware that your co-signer is accepting a lot of risk on your behalf. Be sure to make all of your mortgage payments in full and on time so you don’t damage their credit (as well as your own).
Compare Your Home Loan Options
Not all home loans are created equal. In fact, there are many options for you to consider. Your finances and personal preferences can help you choose the ideal loan. Here are some of the most common types of home loans to put on your radar:
Conventional loans: A conventional loan is a mortgage loan that a homebuyer gets from a private, non-government lender like a bank or credit union. They can vary in terms of borrower eligibility, interest rates, term length, loan limits, down payment, and more. If they are also “conforming loans,” they will meet eligibility and other requirements set by Fannie Mae and Freddie Mac, government-sponsored entities that buy mortgages and package them into bonds. FHA loans: FHA loans are issued by private lenders, but they’re insured by the Federal Housing Administration (FHA). That insurance brings homeownership into reach for many first-time homebuyers with low- or moderate-incomes who might otherwise have a hard time getting approved by a conventional lender. FHA loans usually require lower down payments. VA loans: VA loans are reserved for military service members, veterans, and the spouses and survivors of veterans. They don’t require borrowers to make a down payment or pay for private mortgage insurance, and they’re assumable. USDA loans: Borrowers can use USDA loans, which are also backed by the U.S. government, to purchase, renovate, or refinance a property in certain rural communities across the country. Jumbo loans: A jumbo loan is a home loan that is larger than conforming loans that lenders sell to Fannie Mae and Freddie Mac. Because of their size, they often carry higher interest rates than conforming loans. Because they are “non-conforming,” lenders can set their own eligibility and other requirements.
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